Sarbanes-Oxley and the Competitive Position of U.S. Stock Markets

Congressional research reportJan 11, 2007

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Order Code RL33796

Sarbanes-Oxley and the Competitive Position

of U.S. Stock Markets

January 11, 2007

Mark Jickling

Specialist in Public Finance

Government and Finance Division

Sarbanes-Oxley and

the Competitive Position of U.S. Stock Markets

Summary

Congress passed the Sarbanes-Oxley Act of 2002 (P.L. 107-204) to remedy

weaknesses in accounting and corporate governance exposed by massive fraud at

Enron Corp. and other firms. Criticism of the law, which has been fairly widespread

among business groups, academics, and accountants, focuses on the costs of

compliance, which are said to outweigh the benefits. Several studies and comments

have argued that the rising cost of regulation has created incentives for firms to list

their shares on foreign markets or to withdraw from the public markets altogether,

weakening the international competitive position of U.S. stock exchanges.

Specific evidence cited includes the fact that 24 of the largest 25 initial public

stock offerings (IPOs) in 2005 took place on foreign exchanges, and that there has

been a boom in the private equity market, where U.S. securities regulation is

minimal. This report attempts to put instances like these in context by presenting

comparative data on the world’s major stock markets over the past decade.

In terms of the number of corporations listing their shares, several foreign

markets have shown faster growth than the major U.S. exchanges (the New York

Stock Exchange (NYSE) and Nasdaq). However, these increases appear to be fueled

primarily by growth in the number of domestic firms listing on their own national

markets. While major foreign markets have seen significant declines in foreign

listings as a percentage of all listings, U.S. exchanges have not been abandoned by

foreign companies in significant numbers.

Perhaps the most common reason for firms to delist, or leave a stock exchange,

is a merger with another firm. Lower costs of regulation may be a side benefit of

many mergers, but trends in interest rates and stock prices appear to be the primary

determinants of merger activity. A rising number of corporate acquisitions result in

the acquired firms “going private” — becoming exempt from most regulation — but

this trend is also largely driven by economic conditions. Private equity investment

has boomed since 2000 because debt financing has been abundant and relatively

cheap, and because institutional investors have sought higher yields than what the

stock and bond markets have provided.

Figures on new issues of stock (including IPOs) are volatile, and annual data

may be skewed by a few large deals. Certain foreign exchanges have recovered more

quickly from the 2000-2002 bear market, but, on the whole, there is little evidence

that the U.S. stock market is becoming less attractive to companies seeking to raise

capital. When the bond markets are included, the role of the U.S. securities industry

in capital formation appears to be as strong as ever.

The data surveyed here suggest that rising regulatory costs have not precipitated

any crisis in U.S. markets, and that the outcome of global competition among stock

exchanges depends more on fundamental market conditions than on differentials in

regulatory costs. This report will be updated if events warrant.

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Who Are the Competitors? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Trends in Exchange Listings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Foreign vs. Domestic Listings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

New Listings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Delistings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Mergers, Leveraged Buyouts, Going Private, Going Dark . . . . . . . . . 12

IPOs and Capital Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

List of Figures

Figure 1. Shares of Global Market Capitalization: September 2006 . . . . . . . . . . . 4

Figure 2. Percentage Change Since 1995 in Listings . . . . . . . . . . . . . . . . . . . . . . 6

Figure 3. Foreign Listings as a Percentage of Total: 1995, 2002,

September 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Figure 4. U.S. Corporate Underwriting, 1995-October 2006 . . . . . . . . . . . . . . . 21

List of Tables

Table 1. Market Capitalization of Domestic Shares: September 2006 . . . . . . . . . 4

Table 2. Number of Companies (Domestic and Foreign) Listed on Seven

Major Exchanges: 1995 — September 2006 . . . . . . . . . . . . . . . . . . . . . . . . . 6

Table 3. New Exchange Listings (Total, Domestic, and Foreign Companies):

1995-2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Table 4 . Delistings on Selected Exchanges, 1995-2005 . . . . . . . . . . . . . . . . . . 11

Table 5. Completed Mergers and Acquisitions, 1996-2005 . . . . . . . . . . . . . . . . 13

Table 6. Leveraged Buyouts, 1996-2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Table 7. The Largest Global IPOs in 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Table 8. Value of Equity Offerings on Selected Stock Exchanges,

1996-2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Sarbanes-Oxley and the

Competitive Position of U.S. Stock Markets

Introduction

The Sarbanes-Oxley Act of 2002 (P.L. 107-204) was enacted in response to

massive accounting fraud at Enron and a long list of other U.S. corporations. The law

sought to improve — or restore — the effectiveness of the gatekeepers who are

supposed to ensure that investors receive accurate information about firms whose

securities are traded in public markets. Under Sarbanes-Oxley, corporate executives,

directors, auditors, accountants, attorneys, and regulators are all held to more stringent

standards of accountability.

Criticism of Sarbanes-Oxley has focused on compliance costs, which to some

observers outweigh the benefits of improved governance and regulation.1 Since direct

measurement of those costs and benefits within a single business is impossible, much

of the debate has looked to the securities markets, where excessive regulatory costs

should be mirrored.

Raising the costs of complying with U.S. securities regulation, as Sarbanes-Oxley

unquestionably did, creates incentives both for firms whose securities are listed on U.S.

stock markets and for firms weighing the costs and benefits of going public and

obtaining such listings.2 Firms in the first group (including non-U.S. companies) that

find compliance costs excessive may choose to delist their shares and become privately

held businesses, or list on foreign stock exchanges, where Securities and Exchange

Commission (SEC) regulations do not apply. Firms in the second group may decide

to avoid SEC regulation by remaining private and seeking funds outside the public

securities markets, from private equity investors, for example. They also have the

option of going public in a foreign country. If significant numbers of firms have

decided since 2002 that the costs of U.S. regulation exceed the benefits of access to

U.S. public securities markets (with their traditional advantages of deep liquidity and

low transaction costs), some or all of the following would be expected:

For an overview of criticisms, see Henry N. Butler and Larry E. Ribstein, “The SarbanesOxley Debacle: How to Fix It and What We’ve Learned,” Mar. 13, 2006, available at

[http://www.aei.org/events/filter.all,eventID.1273/summary.asp].

Throughout this report, “public” is used to describe companies that sell their securities to

the general public (and thereby come under SEC regulation) and the markets where those

securities are traded. “Private” (or “privately held”), on the other hand, refers to

corporations that do not report to the SEC because their stock is not available for sale to

small investors.

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a decrease in the number of firms (domestic and foreign) whose shares

are listed on U.S. exchanges, either in absolute terms or relative to

foreign stock exchanges;

an upward trend in delistings, reflecting companies that choose to

leave the U.S. public markets; and

a falling off in the number of new listings on U.S. exchanges, as the

initial public offering (IPO) market shrinks or moves offshore.

Several recent comments and studies have cited evidence that U.S. stock markets

have indeed become less competitive and have suggested that expensive regulation

may be partly to blame.3 Few would argue that Sarbanes-Oxley (or U.S. regulation in

general) is solely responsible for the perceived decline in U.S. markets’ competitive

position. Other factors include several long-term trends, such as (1) the growth of

foreign stock markets, particularly in countries like China and Germany without long

traditions of widespread stock ownership; (2) the lowering of legal and regulatory

barriers to cross-border investment and trading; and (3) the role of computer

technology in reducing communications, information, and transactions costs.

However, policy recommendations to address the perceived decline in competitiveness

tend to focus on regulatory relief, since there is little Congress or regulators can

realistically do to reverse financial globalization or technological progress.

Two facts often put forward are that in 2005, only one of the 25 largest IPOs took

place in the United States, and that going-private transactions have reached extremely

high levels, both in number and value of deals.4 In late 2006, Senator Charles Schumer

and New York Mayor Michael Bloomberg argued that “while New York remains the

dominant global-exchange center, we have been losing ground as the leader in capital

formation.”5

This report attempts to provide a context for evaluating arguments about the

competitive position of U.S. stock markets. The tables and charts below present data

that illustrate trends in global markets since 1995. The first set of data gives a sense

of how the world’s stock exchanges rank in size — in other words, where the

competition lies. Subsequent tables set out data on new listings and delistings at the

major exchanges, and on trends in international listings. Finally, the record in capital

formation is examined: how much have firms raised on the major exchanges through

IPOs, through follow-up stock offerings. Some data ongoing-private transactions are

also presented.

See, e.g., Committee on Capital Markets Regulation, Interim Report, Nov. 30, 2006, at

[http://www.capmktsreg.org/research.html], which argues that “the growth of U.S.

regulatory and compliance costs compared to other developed and respected market centers”

is “certainly one important factor” in the loss of U.S. competitiveness, (p. x.)

Remarks by Treasury Secretary Henry M. Paulson on the Competitiveness of U.S. Capital

Markets to the Economic Club of New York, Nov. 20, 2006, available online at

[http://www.ustreas.gov/press/releases/hp174.htm].

Charles E. Schumer and Michael R. Bloomberg, “To Save New York, Learn From

London,” Wall Street Journal, Nov 1, 2006, p. A18.

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Who Are the Competitors?

The World Federation of Exchanges compiles statistics from 51 stock exchanges

around the world. At the end of September 2006, the market value of shares listed on

these exchanges was about $45.6 trillion, but this was not evenly distributed. There

was a top tier of six exchanges, each with more than $3 trillion in market

capitalization.6 Two of these were American (the New York Stock Exchange (NYSE)

and Nasdaq), two Japanese (the Tokyo and Osaka Stock Exchanges), and two European

(the London Stock Exchange and Euronext).7 These six accounted for $31.3 trillion

in market capitalization, or 70.9% of the total.

There is a second tier of exchanges whose market capitalization fell between $1

trillion and $2 trillion: the Toronto Stock Exchange, the Deutsche Börse, the Hong

Kong Exchanges, the BME Spanish Exchanges, and the Swiss Exchange. These five

markets combined accounted for $6.7 trillion in market capitalization, nearly the same

as the remaining 40 exchanges, which added $6.6 trillion, or 14.4% of the total. Table

1 and Figure 1 set out these figures.

All 51 markets are competitors, but when we think of global competition as

framed by Senator Schumer and Mayor Bloomberg — a struggle to become (or remain)

the world’s financial capital — it makes sense to focus on the top tier, without ignoring

the possibility that the second tier markets may rise to the level of global competitors,

either through growth of the domestic corporate sector, merger with other exchanges,

or cost-saving innovation. Indirect evidence for this assumption is provided by the

recent behavior of the NYSE and Nasdaq, which have responded to competitive

pressures by pursuing mergers with Euronext and the London Stock Exchange,

respectively. This report will present data on the top tier markets, and on the second

tier where it seems appropriate.

The market capitalization figures cover domestic companies only, because inclusion of

foreign listings would cause double counting.

Euronext was formed in 2000 by a merger of the Paris, Brussels, and Amsterdam markets,

and absorbed the Lisbon stock exchange in 2002.

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Table 1. Market Capitalization of Domestic Shares:

September 2006

Market

Capitalization

($ in trillions)

14.37

4.42

3.67

3.44

3.36

3.04

32.30

1.64

1.43

1.36

1.15

1.11

38.99

45.55

Exchange

New York Stock Exchange

Tokyo Stock Exchange

Nasdaq

London Stock Exchange

Euronext

Osaka Stock Exchange

Subtotal

Toronto Stock Exchange

Deutsche Börse

Hong Kong Exchanges

BME Spanish Exchanges

Swiss Exchange

Subtotal

World Total

Percent of

Total

31.55

9.70

8.06

7.55

7.38

6.67

70.91

3.60

3.14

2.99

2.52

2.44

85.60

100.00

Source: World Federation of Exchanges.

Figure 1. Shares of Global Market Capitalization: September 2006

14.4

3.7

3.4

3.0

1.6

1.4

1.2

1.1

4.4

iss

6.6

Source: World Federation of Exchanges.

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Trends in Exchange Listings

When a corporation wishes to have its shares traded on an exchange, it applies to

be listed. Exchange listing standards are not uniform, but generally include

requirements regarding corporate governance practices, financial size or condition,

number of shares available for trading, and minimum share price. In addition, listing

on an exchange brings a company under the jurisdiction of the national securities

regulator.8 Other things being equal, therefore, an exceptionally onerous regulatory

regime ought to discourage growth in the number of listings.

Table 2 presents figures on total exchange listings — both domestic and foreign

companies — from the end of 1995 through September 2006, for the largest stock

markets. Figure 2 rebases the same data as an index (the number of listings at the end

of 1995 is set at 100), and shows the percentage change in the number of listed firms

over the period. (Euronext is excluded from the chart, since it was formed by merger

in 2000: Hong Kong is substituted.9)

A glance at Figure 2 suggests that the major U.S. markets have not fared well

over the last decade. NYSE listings have barely risen, while Nasdaq listings have

fallen sharply. However, factors other than international competition may explain this.

The fall in Nasdaq listings reflects the end of the “dot-com” bubble, when thousands

of listed firms that had never made money (and that in retrospect probably never should

have gone public) collapsed.

In the case of the NYSE, the stability of the listings figure before and after the

bust makes it difficult to argue that any single factor, including the response to the

Enron scandals, had a major impact. NYSE’s listing policy appears to focus on quality

rather than quantity — the exchange’s annual financial statement for 2005 describes

NYSE listing standards as “the most stringent of any securities marketplace in the

world,” and notes that “[a]ll standards are periodically reviewed to ensure that the

NYSE attracts and retains the strongest companies with sustainable business models.”10

In other words, the NYSE may not see growth in the number of listings as a goal to be

pursued for its own sake.

For foreign firms, the full range of regulation does not necessarily apply: foreign

companies listing on U.S. exchanges, for example, are subject to more stringent reporting

requirements when they are raising capital in U.S. markets (i.e., selling new securities to

U.S. investors) than if they are simply seeking a venue for secondary trading of shares

issued elsewhere.

For other second tier exchanges, consistent data is also a problem: the Canadian, Spanish,

and German markets all underwent mergers since 1995.

NYSE Group, Inc., 2005 10-K Report, p. 8.

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Table 2. Number of Companies (Domestic and Foreign) Listed on

Seven Major Exchanges: 1995 — September 2006

Market

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

NYSE

Tokyo

Nasdaq

London

Euronext

Osaka

Hong Kong

2,242

1,791

5,127

2,502

1,222

542

2,476

1,833

5,556

2,623

1,256

583

2,626

1,865

5,487

2,513

1,275

658

2,670

1,890

5,068

2,423

1,272

680

3,025

1,935

4,829

2,274

1,281

708

2,468

2,096

4,734

2,374

1,216

1,310

790

2,400

2,141

4,063

2,332

1,195

1,335

867

2,366

2,153

3,649

2,824

1,114

1,312

978

2,308

2,206

3,294

2,692

1,392

1,140

1,037

2,293

2,306

3,229

2,837

1,333

1,090

1,096

2,270

2,351

3,164

3,091

1,259

1,064

1,135

2,257

2,368

3,130

3,212

1,210

1,070

1,152

Source: World Federation of Exchanges.

Figure 2. Percentage Change Since 1995 in Listings

200

150

100

Index (1995=100)

250

NYSE

Tokyo

Nasdaq

London

Osaka

Hong Kong

Source: World Federation of Exchanges.

What of the markets where listings have increased during the past four years? Has

their growth come at the expense of U.S. exchanges, or was it driven by events in those

exchanges’ home markets? The next set of figures breaks down listings on the leading

exchanges into foreign and domestic companies.

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Foreign vs. Domestic Listings

International crosslisting is a fairly recent phenomenon. Until the late 1980s, only

a handful of stocks traded on exchanges in more than one country. In September 2006,

by contrast, the tabulation of the World Federation of Exchanges showed that of 40,888

total listings on global exchanges, 2,738 represented foreign companies.11 Companies

seek foreign listings for two reasons: better access to foreign capital markets and to

seek a more liquid secondary (or resale) market for their shares, which aids capital

formation in their home market.12 Exchanges seek foreign listings as a source of fee

income and for the prestige of being an international financial center.

Competition for foreign listings is intense, and cost-driven.13 How do the NYSE

and Nasdaq compare to other major exchanges? Figure 3 shows the percentage of

total listings on the major exchanges accounted for by foreign companies, at the end

of 1995 (the earliest point in the World Federation of Exchanges data series), at the end

of 2002 (shortly after the enactment of Sarbanes-Oxley), and at the end of September

2006.

Several features of Figure 3 are striking. First, international cross-listing is much

more common in Europe than elsewhere, as might be expected given the historical

economic interdependence of European states, and after more than a decade of

economic integration policies.14 In the Asian markets, on the other hand, nearly all

listings are domestic. The trend over time is also interesting: in every market other

than the U.S. exchanges, the percentage of foreign listings has fallen since 1995.15 The

decline is most pronounced in the U.K. and German markets, where the percentage of

foreign listings was well above U.S. levels in 1995, but is now very similar. On the

NYSE and Nasdaq, the percentage of foreign listings climbed between 1995 and 2002,

and has since held steady.

See the monthly statistics archive at [http://www.world-exchanges.org]. Note that because

a single company may be listed on multiple exchanges, the 2,738 listings represent a smaller

number of crosslisting firms.

Other things equal, investors will pay a premium for securities that can be resold quickly

and inexpensively.

For example, the NYSE has proposed to eliminate listing fees for companies transferring

from other markets. See NYSE Group, Inc., “NYSE to Eliminate Listing Fee Applicable

to Issuers Transferring from Other Markets,” Press Release, Nov. 29, 2006.

Euronext and the BME Spanish exchanges are excluded because consistent and

comparable data are not available over the period. The September 2006 percentage of

foreign listings on Euronext is 21.2%, but the meaning of “domestic” is not plain where

several national exchanges have consolidated.

Actually, the percentage of foreign listings in Osaka rose, but only from zero to 0.1%.

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Figure 3. Foreign Listings as a Percentage of Total: 1995, 2002,

September 2006

NYSE Nasdaq Toronto German London Swiss

1995

2002

Hong

Kong

Tokyo

Osaka

2006

Source: World Federation of Exchanges.

The data in Figure 3 do not provide clear support for a claim that regulatory costs

have driven foreign firms away from U.S. stock markets. One might argue that the

percentage of foreign listings on Nasdaq and NYSE would have continued their

upward trend had U.S. regulation not been tightened in 2002, but is that likely, given

that foreign listings appear to be in decline on major markets around the world? A

more natural inference from the data would be that Nasdaq and NYSE have remained

competitive, since U.S. exchanges have retained foreign listings since 2002, while

other markets have been losing them.

With the data in Figure 3 in mind, we might suppose that in the markets (shown

in Figure 2) where total listings have risen faster than in the United States — Hong

Kong, London, and Tokyo — growth was driven by new listings of domestic

companies. In Table 3, which breaks out new foreign and domestic listings on the six

largest markets, we can observe this process directly.

New Listings

The data in Table 3 show one common feature: a dropoff in new listings after the

peak of the bull market of the 1990s. In five of the six markets, there were fewer new

listings in 2001 than in 2000. (The exception was the NYSE, where the decline began

earlier and 2000 was the trough year.) This is the predictable result of a global bear

market — trends and levels of stock prices affect the prices investors are willing to pay

for new shares.

The decline in new listings is most dramatic on the Nasdaq and Euronext markets,

probably because more highly speculative business ventures were taken public there

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than elsewhere.16 There is no consistent pattern among the markets in the recovery

from the crash.

Over the 11-year period shown in Table 3, London and Nasdaq are the clear

leaders in the number of new listings, and particularly in domestic listings. Since the

crash, however, the two markets have fared differently: London recorded record

numbers during 2004 and 2005, while Nasdaq remains well below the peak levels of

the late 1990s.

Both U.S. markets registered sharp drops in new listings during 2003, the year

after Sarbanes-Oxley was enacted, despite the fact that stock prices (as measured by the

S&P 500) rose 26% during that year. “Regulatory shock” might explain some of this,

or it may be that firms took a wait-and-see attitude as to whether the recovery in stock

prices from the trough in October 2002 would last. According to Nasdaq’s 2005

Annual Report, “the fluctuation in the number of U.S. IPOs on The Nasdaq Stock

Market from 2003 to 2005 was primarily due to market conditions. Over the past few

years, competition for new listings has come primarily from the NYSE, although there

is also strong international competition.”17 In 2004 and 2005, the number of new

listings on both U.S. markets rose above the low figure of 2003.

This assumes that the bulge in Euronext listings between 1997 and 2000 is the result of

IPO activity, rather than acquisition of new listings through merger with other exchanges.

The WFE data do not make this distinction.

Nasdaq, 2005 Annual Report, p. 9.

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Table 3. New Exchange Listings (Total, Domestic, and Foreign Companies): 1995-2005

Nasdaq

NYSE

Tokyo

Osaka

Euronext

London

Year

Total

Dom.

For.

Total

Dom.

For.

Total

Dom.

For.

Total

Dom.

For.

Total

Dom.

For.

Total

Dom.

For.

1995

476

413

173

138

330

285

1996

655

598

278

219

397

347

1997

648

573

273

210

121

110

254

217

1998

487

437

205

162

287

266

202

169

1999

614

553

151

123

119

102

187

161

2000

605

486

119

122

206

203

108

399

366

2001

144

123

144

245

236

2002

121

151

118

201

193

2003

107

120

201

194

2004

170

147

152

132

153

152

423

413

2005

139

117

146

127

626

605

Note: Euronext figures before 2001 represent the sum of new listings on the Brussels, Amsterdam, and Paris markets.

Source: World Federation of Exchanges.

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Comparing Tables 2 and 3 makes clear that the increase in total listings is

considerably less than the number of new listings. New listings are offset by

delistings, which are set out in Table 4.

Delistings

Table 4 shows no consistent pattern in delisting trends among the six top-tier

exchanges between 1995 and 2005. Nasdaq delistings peaked in 1998 and 1999,

before the end of the boom; the NYSE peak was a year or two later. Neither market

shows an increase in delistings subsequent to 2002.

Table 4 . Delistings on Selected Exchanges, 1995-2005

Year

Nasdaq

NYSE

Tokyo

Osaka

Euronext

London

1995

136

258

1996

121

320

1997

717

171

235

1998

906

194

292

1999

873

254

100

336

2000

700

286

124

299

2001

815

215

140

287

2002

535

145

261

2003

410

111

198

337

2004

322

107

279

2005

332

135

372

Note: Euronext figures before 2001 represent the sum of delistings on the Brussels, Amsterdam, and

Paris markets.

Source: World Federation of Exchanges.

In 2005, 1,011 companies were delisted by the top six exchanges. The

exchanges do not publish statistics on the reasons for delisting. Nasdaq and NYSE

annual reports provide some information, however. Nasdaq reports that delistings

occur for three primary reasons:

failure to meet listing standards (generally minimum financial

criteria);

mergers and acquisitions, where all of the target company’s shares

are purchased by another firm (or traded for shares in the merged

company); and

switching to another venue.18

Nasdaq describes the third reason as occurring “to a lesser extent.” Ibid., p. 10.

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Of the 332 firms that ceased listing on Nasdaq during 2005, 85 (25.6%) had

failed to comply with minimum share price or other financial criteria, or had failed

to file required SEC disclosures on time, which is also grounds for automatic

delisting.19 The NYSE reports a similar percentage: between 2000 and 2005, 27%

of all delistings involved failure to maintain the minimum financial criteria required

for continued listing.20

Of the nearly three-quarters of delistings that happened for reasons other than

financial distress, most involved a change of ownership or a change in the form of

ownership. This includes several forms of transactions:

mergers and acquisitions, where two firms become one;

leveraged buyouts, where a firm’s management or outside investors

purchase all publically traded shares in a listed company and take it

private; and

“going dark” transactions, where a company voluntarily delists itself

from a major exchange and has its shares traded instead on the overthe-counter, or “pink sheets” market. The firm thus becomes exempt

from SEC reporting requirements.

These forms of “voluntary” delistings are where regulatory costs are most likely

to be a factor. The next section analyzes trends in mergers and going-private deals

and the possible role of Sarbanes-Oxley costs.

Mergers, Leveraged Buyouts, Going Private, Going Dark. In most

large corporate mergers, the consolidated firm remains a public company. Thus,

regulatory compliance costs are not eliminated, though they may be reduced as a

percentage of earnings if two public companies merge into one. Basic data about the

corporate merger market, presented in Table 5, do not support an inference that

Sarbanes-Oxley costs are a major factor in the volume of deals. The number and

reported value of deals increased each year between 2002 and 2005, but remained

below the figures for 1998 through 2001, when soaring stock prices encouraged

mergers in which target company stockholders received stock in the acquiring firm

rather than cash payments for their shares.

Ibid., p. 24.

NYSE Group, Inc., 2005 10-K Report, p. 8.

CRS-13

Table 5. Completed Mergers and Acquisitions, 1996-2005

Year

Number of Deals

Value

($ in billions)

1996

7,347

563.0

1997

8,479

771.5

1998

10,193

1,373.8

1999

9,173

1,422.9

2000

8,853

1,781.6

2001

6,296

1,155.8

2002

5,497

625.0

2003

5,959

521.5

2004

7,031

857.1

2005

7,298

980.8

Source: Thomson Financial. (Only deals worth more than

$10 million are included, and dollar figures include only

deals for which price data was made public.)

Table 6. Leveraged Buyouts, 1996-2005

Year

Number of Deals

Value ($ billions)

1996

189

20.1

1997

192

15.4

1998

186

22.3

1999

197

28.7

2000

305

51.2

2001

153

18.9

2002

163

24.8

2003

164

41.4

2004

327

82.0

2005

450

117.4

Source: Thomson Financial. (Only deals worth more than

$10 million are included, and dollar figures include only

deals for which price data was made public.)

CRS-14

One of the benefits to corporations involved in leveraged buyouts, a subset of

corporate mergers in which all public shares are purchased and taken off the market,

is the elimination of SEC compliance costs. This market has shown rapid growth

since 2001, as shown in Table 6. How much of the rise can be attributed to

increased regulatory costs? Several studies have addressed this question by

attempting to measure changes in the propensity of U.S. firms to go private before

and after Sarbanes-Oxley. Kamar, Karaca-Mandic, and Talley find that small firms

were induced to leave the public markets, but that large firms were unaffected.21

Engel, Hayes, and Wang find a “modest but statistically significant increase in the

rate at which firms go private in the post-SOX period,” with the effect more

pronounced among smaller firms.22 Other researchers address the difficulty of

separating the impact of regulatory costs from other factors:

Because buyouts occur for many reasons, and SEC disclosures to shareholders

in public companies will focus on the value of the consideration to be received

compared to current market values, it is difficult to determine what role the costs

of compliance with SOX and other securities laws played in these decisions.23

An important factor behind the increase in leveraged buyouts is the rise of the

private equity market. Private equity investors purchase companies, either private

or public, and seek to improve operating results by restructuring or by providing

capital. The activity is not new, but is now a more significant factor in the market

than ever before. The growth has been driven by institutional investors searching for

higher returns. Yields on both debt and equity investment in the public markets have

been depressed over the past several years: blue-chip stock indexes remained below

2000 levels until the fall of 2006, while both long- and short-term interest rates have

been low by historical standards. At the same time, there has been a “glut” of

international capital seeking investment opportunities, making capital abundant at

low interest rates.24 As a result,”alternative” investments have thrived, including

private equity funds.

In short, the boom in mergers and private equity has been produced by a

combination of economic factors and market conditions. The boom continued in

2006, as a recent Business Week article attests:

[W]hat’s driving this year’s merger mania is quite different from what prompted

AOL to plop down $182 billion for Time Warner Inc. in 2000. That boom was

fueled by inflated stock prices in an overheated equities market that made

Ehud Kamar, Pinar Karaca-Mandic, and Eric L. Talley, “Going-Private Decisions and the

Sarbanes-Oxley Act of 2002: A Cross-Country Analysis,” USC CLEO Research Paper No.

C06-5, August 2006, 60 p.

Ellen Engel, Rachel M. Hayes, and Xue Wang, “The Sarbanes-Oxley Act and Firms’

Going-Private Decisions,” May 6, 2004, p. 3. Available at SSRN: [http://ssrn.com/

abstract=546626]

William J. Carney, “The Costs of Being Public After Sarbanes-Oxley: The Irony of

‘Going Private,’” Emory Law and Economics Research Paper No. 05-4, February 2005, p.

13.

See CRS Report RL33140, Is the U.S. Trade Deficit Caused by a Global Saving Glut? by

Marc Labonte.

CRS-15

companies feel like they were playing with funny money. This time the drivers

are low interest rates, low valuations, and robust debt markets. One telling

difference: 60% of this year’s deals have been paid for in cash, vs. 29% in

2000.... The biggest change, though, is the unprecedented heft of private equity

firms. Morgan Stanley estimates that buyout shops are now armed with at least

$2 trillion in purchasing power, far more than ever before. The number of

public-to-private deals in 2006 is set to nearly double the number in 2000, to 205,

while their value has soared more than tenfold, says Paul J. Taubman, global

head of M&A at Morgan Stanley. Yet there’s still plenty of room for the boom

to continue. Many companies still look cheap.25

Preliminary figures indicate that the value of companies taken private in 2006

reached a record level: $150 billion worldwide, with former NYSE listings

representing $38.8 billion; London, $27 billion; and Nasdaq, $11 billion.26

Another way a public firm can shed its SEC reporting burden is by “going dark.”

In this process, firms voluntarily give up their exchange listing and deregister with

the SEC.27 They do not entirely abandon the public markets; their shares continue

to trade on the over-the-counter (or “pink sheets”) markets. Several studies have

linked Sarbanes-Oxley costs to the growing number of going-dark transactions in

recent years.28

However, firms that go dark are not a representative cross section of listed

companies. The studies find that they tend to have serious financial problems (which

might have led to an involuntary delisting by the exchange). In addition, Leuz,

Triantis, and Wang find evidence that “controlling insiders go dark to protect their

private control benefits and decrease outside scrutiny, particularly when corporate

governance is weak and outside investors are less protected.”29

Healthy firms rarely go dark because there is typically a strong negative market

reaction. Thus, even if the causal link between rising regulatory costs and going-dark

transactions is robust, the competitive position of U.S. markets may not suffer as a

Emily Thornton, “What’s Behind the Buyout Binge: Merger Monday,” Business Week,

Dec. 4, 2006, p. 38. See also the Committee on Capital Market Regulation’s Interim

Report for discussion of the growing liquidity in the private equity market, with the

development of secondary trading of limited partnership interests (pp. 34-38).

Peter Smith and Norma Cohen, “Record $150bn of Delistings,” Financial Times, Jan. 2,

2007, p. 1.

In order to deregister, firms must have had fewer than 300 shareholders of record (or

fewer than 500 shareholders and less than $10 million in assets) for the preceding three

years. When deregistration is complete, the firm ceases filing financial statements with the

SEC.

Christian Leuz, Alexander J. Triantis, and Tracy Yue Wang, “Why do Firms go Dark?

Causes and Economic Consequences of Voluntary SEC Deregistrations,” Robert H. Smith

School Research Paper No. RHS 06-045, March 2006, 58 p. and: Engel, Hayes, and Wang,

“The Sarbanes-Oxley Act and Firms’ Going-Private Decisions.”

“Why do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC

Deregistrations,” p. 3.

CRS-16

result: firms going dark are unlikely to be subject to international competition for

listing.

IPOs and Capital Formation

The discussion above has focused on the number of companies listing on U.S.

and competing international exchanges, but listing trends are only part of the picture.

The basic economic function of a securities market is to intermediate between savers

and businesses seeking investment capital. The capacity of an exchange to facilitate

capital formation is also an indicator of its competitive position.

One of the most frequent claims regarding the declining competitiveness of U.S.

markets is that they now handle a much smaller share of the world’s initial public

offerings than they once did. Of particular concern is the fact that of the 25 largest

IPOs in the world in 2005, only one took place on an American exchange. Have

rising regulatory costs driven U.S. firms abroad in search of equity capital, or have

foreign firms that might have considered a U.S. offering gone elsewhere?

To begin with the first question, an examination of the 25 largest IPO deals (set

out in Table 7) suggests that the answer is no. The only firm on the list domiciled

in the United States listed its shares on the NYSE.

Table 7 is dominated by French (five) and Chinese (four) IPOs. Most of these

deals, including the China Construction Bank Corporation, the China Shenhua

Energy Limited, the Bank of Communications, the China COSCO Holding

Company, and France’s Electricite de France, Gez de France, Sanef, and Eutelsat,

were privatizations of huge state-owned enterprises. It seems unlikely that the

French or Chinese governments would look favorably on a foreign listing for these

firms.

The table indicates that most of the IPO firms chose to list their shares on

domestic exchanges. For example, all the Chinese firms listed on the Hong Kong

Stock Exchange and all of the French firms listed on Euronext. The same holds true

for the Austrian, Australian, Danish, Dutch, German, and Japanese firms.30

It may be noteworthy that the exceptions to this pattern — the two companies

from Russia and Kazakhstan — chose to list in London. Regulatory considerations

may have been a factor in this choice. Did the NYSE or Nasdaq seek to obtain these

listings?31

Ernst & Young, which compiled the list, states that the Chinese Government played a role

in encouraging firms to list on the Hong Kong Stock Exchange, in order to bolster the firms’

good governance credentials. See Ernst & Young, “Accelerating Growth,” Global IPO

Trends 2006, February 2006, p. 15.

A search of periodical databases yields no hint that they did. (Kazakhmys stock trades in

the United States on the over-the-counter “pink sheets” market, suggesting that it might not

meet Nasdaq listing standards.) On the other hand, the London Stock Exchange appears to

have pursued listings from ex-Soviet countries energetically: “More than 40 Russian

(continued...)

CRS-17

Table 7. The Largest Global IPOs in 2005

(in millions of U.S. $)

Company

Domicile

Industry

Proceeds

Primary

Exchange Listing

China Construction

Bank Corp.

China

Banks

9,227

Hong Kong

Electricite de France

France

Energy and Power

8,200

Euronext

Gaz de France

France

Energy and Power

4,128

Euronext

China Shenhua

Energy Ltd.

China

Mining

3,276

Hong Kong

Bank of

Communications

China

Banks

2,165

Hong Kong

Tele Atlas N.V.

Netherlands

High Technology

1,946

Euronext

Partygaming

Gibraltar

Professional Services

1,658

London

Goodman Felder

Ltd.

Australia

Consumer Stables

1,599

Australia

AFK Sistema

Russia

High Technology

1,593

London

Huntsman Corp.

U.S.

Materials

1,593

New York

Raiffeisen

International Bank

Austria

Financials

1,456

Vienna

Premiere AG

Germany

Media and

Entertainment

1,354

Frankfurt

SUMCO Corp.

Japan

High Technology

1,346

Tokyo

China COSCO

Holdings

China

Marine Transport

1,227

Hong Kong

Spark Infrastructure

Group

Australia

Energy and Power

1,223

Australia

Telenet Holding NV

Belgium

Telecommunications

1,190

Euronext

Consumer Staples

1,171

London

Kazakhmys

Kazakhstan

Energy and Power

1,166

London

EFG International

Switzerland

Financials

1,097

Swiss Exchange

Sanef

France

Industrials

1,088

Euronext

SP Ausnet

Australia

Energy and Power

1,057

Australia

Eutelsat

France

Telecommunications

1,030

Euronext

EuroCommercial

Properties

France

Real Estate

1,026

Euronext

TrygVesta

Denmark

Financials

1,008

Copenhagen

RHM

Source: Ernst & Young.

(...continued)

companies attended a London Stock Exchange ‘roadshow’ last year. Several are tipped to

seek listings in the coming months, including Open Investments, owned by Vladimir

Potanin, the Norilsk Nickel billionaire.” See Conal Walsh, “Russia’s ‘Google’ aims for

London share listing,” The Observer (London), Jun. 12, 2005, p. 2.

CRS-18

Table 8 presents more comprehensive statistics on the IPO market, showing the

value of equity offerings on the six top-tier exchanges and Hong Kong (a second-tier

exchange that appears several times in Table 7). Total equity issues include both

IPOs and sales of new stock by established public companies.

These figures show considerable year-to-year volatility, reflecting not only the

variability of stock prices (which affect the attractiveness of equity sales as a means

of raising capital) but also the skewing of single-year data by the presence (or

absence) of a few very large transactions. The ratio of IPOs to offerings by

established public companies also shows great variation from year to year, probably

reflecting the impact of large individual transactions in either category.

Preliminary data suggest that 2006 was a record year for IPOs, with global

underwriting exceeding $250 billion.32 Russian and Chinese firms accounted for just

over a quarter of this total. IPO value on Euronext was up 60% (to $24.5 billion)

over 2005, and doubled on the Deutsche Börse (to $8.8 billion). IPOs on the NYSE

raised a total of $25 billion in proceeds (excluding closed-end mutual funds) in 2006.

There were 18 IPOs by non-U.S. companies, raising $6.5 billion.33 The NYSE

continues to be a big fish, but the IPO pond is growing.

The most visible international trend is that all markets show a significant drop

in equity underwriting in 2000 or 2001, with the end of the bull market.34 The

performance of the two U.S. exchanges since that time is markedly different: Nasdaq

underwritings remain far below the boom levels — 2005 equity issues were less than

10% of the 2000 peak. On the NYSE, by contrast, the 2005 figure was 78% of the

2000 level.

The post-2000 recoveries in equity issuance on the European exchanges have

been strong; London experienced only a mild drop-off and reached a record high in

2004, while Euronext in 2005 recorded 75% of its 2000 peak, very similar to the

NYSE experience.

What does Table 8 suggest about the competitiveness of U.S. markets? The

most striking fact is the dominance of the NYSE as a market for new equity. Its $175

billion in 2005 underwriting was more than double that of the nearest competitor, and

in fact accounted for 29.3% of total global equity issues. However, the argument is

Norma Cohen and Peter Smith, “Upsurge in IPOs and Private Deals,” Financial Times,

Jan. 2, 2007, p. 15. In the authors’ view, U.S. regulation does not account for the “relative

decline in popularity of U.S. exchanges.” Rather, they argue, “companies domiciled outside

the U.S. increasingly look to their maturing home markets, or to the largest capital market

closest to them, as a listing venue of choice.”

NYSE Group, Inc., “2006 Highlights,” Press Release, Dec. 29, 2006.

In securities markets, underwriting refers to the process by which companies raise capital

by selling (also called issuing) stocks or bonds to investors. This is also known as the

primary market, as distinguished from the secondary (or resale) market, where investors

trade securities among themselves and the company that originally issued the securities does

not share in the proceeds.

CRS-19

made that the degree of supremacy is diminishing — in 1996, the NYSE accounted

for 38.3% of the value of global equity issues.35

Several factors underlie the growing share of equity issuance going to foreign

markets. Many countries in the world did not have well-developed equity markets

until recently; these include not only China and Eastern Europe, but also France,

Germany, and other continental European states where corporate finance was

historically dominated by universal banks. Economic liberalization has provided an

impetus for the development of equity financing, and computer technology has made

it possible to replicate the sophisticated trading mechanisms of the New York and

London exchanges at relatively low cost.36 Markets have also expanded rapidly in

the high-growth emerging economies of Asia and Latin America.

In short, the fact that U.S. stock exchanges are losing market share in global

equity trading may reflect positive developments elsewhere, rather than impediments

imposed here by regulatory and other burdens. NYSE and Nasdaq have certainly not

been complacent in the face of rising competition. On the contrary, they have taken

steps like the following:

pursued mergers with major foreign exchanges (NYSE with

Euronext, Nasdaq with London);37

invested heavily in new trading technology to compete with

alternative trading systems (cheap, computerized transaction

facilities); and

restructured themselves as for-profit, shareholder-owned

corporations, in part to prevent entrenched exchange constituencies

(such as the NYSE specialists) with a financial stake in the status

quo from blocking innovations needed to remain competitive.

Global totals from World Federation of Exchanges, annual statistics archive.

Cheap computer technology has inspired many predictions of the imminent demise of the

NYSE over the past decade or so.

In fact, the mergers are driven in large part by the European markets’ need to cut their

trading costs to U.S. levels, rather than U.S. markets’ fear of competition. See “Finance and

Economics: A War on Two Fronts; Stock Exchanges,” Economist, vol. 381, Nov. 18, 2006,

p. 92.

CRS-20

Table 8. Value of Equity Offerings on Selected Stock Exchanges, 1996-2005

(dollars in billions)

NYSE

Nasdaq

London

IPO Other Total

1996

50.0

111.0

161.0

24.1

27.7

1997

43.9

133.7

177.6

11.0

1998

43.7

112.7

156.4

1999

71.4

129.5

2000

73.3

2001

Euronext

Tokyo

Osaka

Hong Kong

IPO Other Total IPO Other Total

Total

IPO Other Total

51.8

16.7

14.0

30.7

19.0

4.0

8.9

12.9

25.2

36.2

11.6

10.7

22.3

9.5

10.5

21.1

31.6

13.8

19.7

33.5

6.6

10.8

17.4

11.8

0.8

4.2

5.0

200.9

50.4

53.5

103.9

7.4

16.0

23.4

89.2

2.2

17.0

19.2

149.7

223.0

52.6

80.8

133.4

14.8

21.3

36.1

49.4

38.0

87.4

16.7

17.0

60.0

77.0

28.5

49.3

77.8

7.8

24.0

31.8

7.8

21.0

28.8

32.1

45.3

77.4

16.9

3.3

8.0

11.3

2002

27.2

60.2

87.4

4.5

8.1

26.3

34.4

3.5

32.5

36.0

15.7

0.1

2.2

2.3

6.7

7.5

14.2

2003

27.4

54.2

81.6

6.4

7.8

22.6

30.4

0.7

50.5

51.2

29.0

0.1

4.9

5.0

7.6

19.9

27.5

2004

54.5

93.4

147.9

15.0

13.8

18.6

32.4

11.7

33.2

44.9

25.9

0.3

5.2

5.5

12.5

23.7

36.2

2005

44.1

130.9

175.0

12.2

31.2

20.7

51.9

21.2

44.7

65.9

24.6

0.3

6.2

6.5

21.3

17.0

38.3

Year

Source: World Federation of Exchanges. (Tokyo figures are not broken down into IPOs and follow-on offerings.)

IPO

Other Total

CRS-21

Finally, while equity markets have been an important locus for capital formation

for U.S. businesses, they are only part of the larger securities market. Corporations

seeking investment funds have many options, and in recent years of low interest rates

they have turned increasingly to the bond markets. Figure 4 shows annual dollar

figures for U.S. corporate underwriting between 1996 and November of 2006. Total

underwriting, which measures funds going directly to firms issuing securities, has

shown a fairly steady rise throughout the period, suggesting that costs related to the

Sarbanes-Oxley Act’s tightening of securities regulation have not materially harmed

U.S. businesses’ ability to raise funds in securities markets.

Figure 4. U.S. Corporate Underwriting, 1995-October 2006

3.5

2.5

1.5

0.5

Equity

Debt

Source: Securities Industry Association.

Conclusion

This report has not attempted to make a direct measurement of the impact of

Sarbanes-Oxley compliance costs on firm behavior in the equity markets. Instead,

the data presented above seek to provide a context for evaluating claims that such

costs have put U.S. stock markets at a competitive disadvantage. There have been

three developments in recent years that might plausibly be attributed (at least in part)

to rising regulatory costs:

over the past decade, the total number of listed companies on U.S.

exchanges has fallen (in the case of Nasdaq) or failed to grow (in the

case of the NYSE), while several foreign exchanges (notably Hong

CRS-22

Kong, Tokyo, and London) have experienced significant growth in

listings;

there has been a boom in the number and size of going-private

transactions, which result in firms being taken off the public markets

and outside the SEC’s regulatory jurisdiction; and

the share of global IPO volume handled by U.S. markets has fallen,

especially among the very largest deals.

However, there are alternative explanations for each of these phenomena, based

on market conditions and global economic trends:

The drop in Nasdaq listings must be viewed in the context of the

aftermath of the 1990s bubble, when thousands of technology firms

were taken public even though they had no real prospects of ever

turning a profit. The NYSE’s stable listings figure, on the other

hand, may be due to a policy of maintaining stringent listing

standards that exclude all but the largest and most financially sound

corporations.

The private equity boom has been driven by market forces including

the availability of relatively abundant and inexpensive debt

financing, the pressure on pension fund managers and other

institutional investors to seek returns higher than those offered since

2000 by traditional investment classes, and the high compensation

levels earned by private equity managers.38 Research has indicated

that rising regulatory costs have a discernible impact on goingprivate decisions primarily among small firms, particularly those

with financial or governance problems.

Growth in foreign equity underwriting appears to reflect growth in

foreign economies (such as China’s) and/or the development of

equity markets in countries that historically relied on bank financing

(such as Germany). Corporations continue to show a strong

preference for listing on their domestic market, or the closest major

financial center. The data do not suggest that many U.S. firms are

choosing to list on foreign exchanges, or that foreign firms have

abandoned U.S. markets in significant numbers since SarbanesOxley was enacted.

The impact of Sarbanes-Oxley costs is difficult to measure, but quantification

of the benefits is even more elusive. It is worth noting, however, that international

competition among stock markets has not up to now taken the form of a regulatory

“race to the bottom,” in which markets attempt to lure companies by offering a more

lax regulatory regime than their competitors. There is no equivalent in equity

Andrew Ross Sorkin and Eric Dash, “Private Firms Lure CEOs with Top Pay,” New York

Times, Jan. 8, 2007, p. A1.

CRS-23

markets to the offshore banking centers and tax havens that thrive in small

jurisdictions like the Dutch Antilles, the Isle of Man, or Vanuatu. This fact reflects

a market judgement that investor confidence, which is nurtured by the perception that

exchanges and regulators devote significant resources to the prevention of fraud, has

real economic value. Where stock market growth has been fastest, as in London and

Hong Kong, the securities regulators are generally recognized as capable and

vigorous.

The outcome of global stock market competition has different implications for

different market participants. If U.S. issuers and traders go overseas, to take

advantage of lower regulatory or other costs, the U.S. securities industry will suffer

a loss of output and jobs. That industry is concentrated heavily in the greater New

York area and, to a lesser extent, Chicago. The cost to the U.S. economy of such a

shift, however, would be partially offset by lower trading and underwriting costs,

which would mean higher returns for public investors and more efficient business

investment spending. To the investors and businesses who use the market, the

ranking of the U.S. securities industry in the world market is of secondary

importance. If U.S. markets remain competitive, both the industry and its customers

can continue to thrive. The United States has been (and continues to be) the world

leader in the adoption of new, cost-saving technology and in the elimination of anticompetitive market structures and practices. International market trends over the past

several years do not provide strong evidence that a serious loss of competitiveness

has occurred, or that such a loss is inevitable unless regulatory costs are reduced

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.